China-U.S. Summit Avoids Showdown On Audit Inspections

US Treasury Secretary Timothy Geithner attends the joint statment reading for the closing of the US-China Strategic and Economic Dialogue at the Diaoyutai Guesthouse in Beijing on May 4, 2012 (Image credit: AFP/Getty Images via @daylife)

Treasury Secretary Timothy Geithner led a full team to Beijing for last week's economic talks, which were largely eclipsed in U.S. coverage by Chen Guangcheng's bid for freedom. As usual, the joint Sino-American declaration was long on rhetoric and short of specifics. One issue that received passing mention was auditing of public companies. The two sides said they supported "the objective of a single set of high quality global accounting standards." But the thorny issue of U.S. oversight of Chinese audits of U.S-listed companies wasn't directly addressed. This matters greatly for investors who bought into Chinese stocks that tanked when their financial shortcomings were revealed, often by short-sellers like Muddy Waters. Attention swiftly turned to the global accounting firms that signed off on scandal-hit company accounts. Enter the Public Company Accounting Oversight Board (PCAOB), the U.S. agency tasked with certifying auditors of all listed firms, in whatever jurisdiction. After a wave of stock implosions, that definitely includes China. But the path ahead isn't easy. Deloitte is battling the S.E.C. over its auditing of Longtop Financial, its former client. Chinese officials have a reflexive distrust of U.S. agencies poking their nose into domestic affairs.

On Geithner's 19-person team was James Doty, the PCAOB's chairman. His mission to get access to China's accounting industry wasn't highlighted in the joint statement, but that doesn't mean his visit was a bust. Paul Gillis, who writes the China Accounting Blog and teaches at Peking University, says the two sides are already making progress and likely eschewed a line in the statement in order to keep talking. Doty didn't attend last year's summit and presumably didn't go away empty handed. But Gillis warns that the clock is ticking for a solution. "The pressure is mounting for the PCAOB to do something," he says.

Even before the current backlash against Chinese stocks, the clock was ticking. Three years ago, the PCAOB set 2012 as its deadline for inspecting overseas auditors of listed companies. Companies who don't have PCAOB-certified auditors face being delisted from U.S. exchanges under S.E.C. rules. China isn't the only jurisdiction on the agency's to-do list, but the sheer number of listed Chinese companies (over 200) makes it a priority. Last month China Auto Rental cancelled an IPO amid lukewarm U.S. appetite for China stocks. So the market has drawn its own conclusions. Gillis points out that U.S. companies that produce and distribute products in China are also in the spotlight. Their U.S.-based auditors must verify their Chinese accounts to be in compliance with U.S. securities law. Should the Big Four's local affiliates in China be struck off the approved list, then U.S. companies would face a problem in auditing their operations in China. This is one reason why the PCAOB will keep pushing for access to China.